Estate Planning 3
Sustainable Civilization: From the Grass Roots Up Estate and Financial Planning - Providing Assets for the Future - 2 - 3 - 4 - 5 - 6 - 7 - 8 FINANCIAL PLANNING GETTING STARTED Do you have questions or concerns about your financial future? Have you planned for your continued education? Have you considered the responsibilities and costs of marriage (or divorce), raising children, college education for your children, and your retirement years? Or, perhaps, are you too far in debt? Step One - Gather information. Perhaps a first logical step is to gather together into one document all of your basic information (names, accounts, contact points, etc.). For those interested, we have posted at the YPG intranet site an organizing outline document (18 pages PDF format - entitled PEACE OF MIND PLAN), prepared by the JAG school. Step Two - Set up a budget. It is obvious that to invest for your future, you can't spend your entire income on consumer goods and services. If you need help setting up a family budget, the ACS office here at YPG offers this service, or if your situation is more complicated, call for legal assistance review. It is important to arrange you budget such that you can begin some type of investment program as early as possible. Due to the effects that compounded interest will have on the final value of your investments, a delay of even a few years in STARTING your investment program, and have LARGE effects on the total amount you have in the future. Step Three - Envision your future. Where do you want to go? What do you want in your retirement years? Are you prepared for the burdens of caring for a family member (or they for you) during a period of long term disability? Do you plan on providing a college education for your children? Can you family continue to live with the same lifestyle in the event of your death? Do you have your debts under control? In general, the higher your formal education, the higher your lifetime income. Active duty members have a variety of tuition assistance options. Regardless of your status though, you still have many options to pursue an education. In additional to traditional classroom attendance, there are legitimate correspondence programs, "online" programs, and it is even possible to completely earn a Bachelor's Degree by simply taking tests. Whether active duty, civil service, or employed in the civilian sector, take a pro-active interest in advancement: examine your position, your capabilities, and the requirements for advancement. If there's a different job you think would be perfect for you, work toward getting yourself qualified for it. Step Four - Protect your present assets, and your future goals. Do you have the right types of insurance coverage? Do you ENOUGH insurance coverage? Are you getting a "good deal" on your insurance? (i.e. for life insurance, there are websites when you can make your initial inquiries about policy costs, which when contracted for directly with the insurance company, SAVES you the fees which would otherwise go to the local insurance agent.) Liability insurance, not only on your vehicle, but some type of "umbrella" policy that covers your personal liability for events other than a car accident. (i.e. what if you trip someone while you're at the mall, and they sue you?) These policies are often a rider to homeowners or renters insurance. Homeowners / Renters insurance. Provides for replacement of your personal property for covered events (i.e. theft, fire, or other destruction), as well as liability protection for accidents that take place on your property. For example, if you live in quarters, and your child accidentally starts a fire that destroys all of your personal items, as well as the government owned home, could you afford to pay "out of pocket" for all of the damage? Life insurance. SGLI is offered for military members in up to $250,000 coverage. SGLI terminates though 120 days after you retire or leave the service. In addition, have you considered, is this sufficient to truly provide for your family in the absence of your income? Many couples with children, where for example the non military spouse does not work outside the home, ignore coverage on the non military or non working spouse, thinking there is no income to be replaced. There is however a significant impact on the surviving family when they must pay someone else for services such as child care, that were otherwise being provided "free". While there are variations, the two basic forms of life insurance. First, is "whole life", where the policy accumulates over time some manner of "cash value" which can be "borrowed" or considered as a form of investment. AS the name implies, it is generally a type of life insurance where the coverage can be maintained for your entire lifetime. The documents presented to you as part of the "sales pitch" often includes projections of significant profits within the policy. Read the details carefully, and look for the amounts that the company guarantees, rather than mere estimates. (The fact that any particular class of investment advanced significantly in the PAST, does not necessarily mean it will do so in the future.) Second, is "term insurance", which is what the SGLI program is. Term insurance provides a much higher amount of coverage, for much less cost, because it has no "investment" aspect. When the policy ends, nothing remains. The "term" aspect generally refers to the period of time during which the company has agreed to provide insurance coverage and the costs for that period. More often than with whole life policies, you will find that term policies have costs that increase as you age. If your first priority is to provide a "safety net" for your family, your first priority is sufficient term insurance to meet those needs. After the safety net is met, whole life can then be considered as one of they many means (including also the world of "TSP", "Individual Retirement Accounts", mutual funds, money market accounts, real estate, etc.) available for investing for your future. Long term care. If the need for nursing home care has "run in your family", or some aspect of your personal life indicates to you a likelihood that you may need nursing home care, you should note that the earlier you take out such a policy, the lower the payments, often even when the payments are aggregated over time. Step Five - Savings. This refers to short-term financial goals, such as saving for a vacation, for that Christmas shopping spree, a car, etc. These funds are typically kept in bank or credit union deposits, money market funds, etc. An approach to savings is payroll deductions for federal "Savings Bonds", which have the advantage that the interest on the bonds builds up "tax-deferred", meaning you do not pay tax on the interest until you turn the bond in for cash. They can be redeemed at any bank, at any time later than six months after purchase. These bonds carry the additional benefit that at the maturity date of the bond you can exchange it for a class H bond. A class H bond pays you interest you can put in your pocket and spend. While the interest actually paid out to you from an H bond is taxable, there was no tax on the E bond interest while it accrued, and there was no tax when you exchanged the E for the H. This combination give the E - H combination advantages over commercial savings accounts. Step Six - Investments. These are purchases you make with the intent and hope that the item purchased increases in value significantly faster than the general inflation rate, or bank interest. Real estate. For most people, a home is the largest purchase they make. If you are not living in your home, it can be rented, which may have significant income tax advantages for you. While unimproved land (without a building) can be an investment, it typically does not have the tax advantages of "depreciation". TSP. Federal military and civilian employees have the option to defer a portion of their income into a "Thrift Savings Plan". The money sent there from you salary is not considered taxable income during your current tax year, and should not be subject to withholding for taxes. In addition "Uncle Sam" makes some type of matching contribution. All of the money in your TSP accumulates profits, yet is not subject to income tax so long as it remains in the account. These factors combine to make the TSP account far more attractive than making similar investments with after-tax money. IRA. Depending on your income tax bracket, you may also be able to make tax deferred investments in an "Individual Retirement Account". A comparison of tax deductible IRA/TSP and the same investment after taxes (using a 25% tax bracket as an example, and 5% annual interest) is below. Both columns below indicate an investment that amounts to $1500 "out of pocket". The first advantage of a pre-tax investment here is that to have $2000 each year deposited, it only "costs" you $1500 of the money that would otherwise be in your pocket. The other $500.00 going into your investment is money that you would have otherwise paid as income tax. As you can see, just over a five year period, the difference is substantial. IRA/TSP Brokerage Open account $2000.00 $1500.00 Interest during year 1 $100.00 $75.00 -$18.75(income tax) Deposit year 2 $2000.00 $1500.00 subtotal $4100.00 $3056.25 Interest during year 2 $205.00 $152.81 -$38.20 (income tax) Deposit year 3 $2000.00 $1500.00 subtotal $6305.00 $4670.86 Interest during year 3 $315.25 $233.54 -$58.39 (income tax) Deposit year 4 $2000.00 $1500.00 Subtotal $8620.25 $6346.01 Interest during year 4 $431.01 $317.30 -$79.33 (income tax) Deposit year 5 $2000.00 $1500.00 subtotal $11051.26 $8083.98 Interest during year 5 $552.56 $404.20 -$101.05 (income tax) Total at end of year 5 $11573.82 $8387.13 ROTH IRA. Even if your tax bracket means you cannot deduct the deposits to a "traditional" IRA, you should consider the ROTH IRA. While you cannot deduct the deposits from this year's income tax, all of the profits still accumulate tax deferred, and if you comply with the other applicable rules, the money is also NOT taxed when you withdraw it. A significant additional aspect of a ROTH IRA is the ability (as of 2006 law) to withdraw at any time your contributions WITHOUT any tax or penalty. This allows a ROTH to function as an "Emergency" savings account to hold your "cash". While you must in general leave all interest/profits in the account, there are exemptions for the profits also. - The account must have been in existence 5 years. - If you are not 59 1/2 or older, then the withdrawal of profits must: - Be used to buy or rebuild a "first home" as defined in PUB 590; or - You must be disabled as defined in PUB 590 In either type of IRA, you have a wide selection of custodians (places where you make your deposit) and investments. Your IRA can be invested in stocks, bonds, mutual funds, bond funds, some option contracts, gold coins, and even real estate. Purchasing a Pension. Yet you may not realize it, but even if you are not making cash deposits, in some manner you are “buying” your retirement plan. Active duty must invest at least 20 years of service, and then become eligible for a lifetime pension. Your pension is determined by the rank you achieve, therefore it is in your best interest during your career to progress as high as possible in the ranks. Although you do not actually make any cash deposit to purchase your pension, I'd like to put it's value in perspective. Assume an 18 year old enters the military, does a 20 year career, and retires at 38 at an E-7. Your pension will be around $1600 per month for life. Assume living at least 40 more years until age 78. If interest rates when you retire are around 5%, at age 38 the economic value to you of the upcoming 40 years of checks is as if you had around $330,000 in the bank. Assuming the same 5% interest rate, over the 20 years you served, if you had wanted to invest and have $330,000 in the bank you would have had to start saving $815 per month in a tax deferred account, and put $815 in every month you served, to simulate the value of your active duty pension. Whole Life Insurance. Although discussed above in insurance, it is really at this level in your financial plan that "whole life" type policies become a practical investment. They are a tool to use "after tax" earnings to invest further in tax-deferred, or potentially tax free investment programs. There are many insurance companies, among which you may find essentially identical investment options, but with widely differing costs to you. Be sure to check out the safety rating of the company. Remember, the company is in business to make money, as is the company agent. Read your contracts carefully. Educational IRA's. While often improperly referred to as IRA's, there are available investment accounts, which if properly set up, the investment can grow tax deferred, and withdrawn tax free if used to pay for the education of your child. Step Seven - Specific Goals. Achieving a goal starts with a dream, and determining the clear steps required to reach it. Along with achieving goals, "life happens". Besides daily living expenses, you may need to buy a car, pay off debts, save for your children’s education, take a vacation, or buy a home. You may have aging parents to support. You may be going through a major event in your life such as starting a new job, getting married or divorced, raising children, or experiencing a death in the family. The point is to not lose sight of your long term goals. Start by writing down each of your goals so you can organize them easily. This is your “wish list.” Sort it by the date to be accomplished, because you save for short-term and long-term goals differently. Make retirement a priority! Even if you're going to have a secure lifetime income check coming to you, how well you can live on that income is greatly effected by the other preparations you make. If you don't believe your pension will be enough to pay your day to day expenses, as well as a mortgage or rent, you should either invest to purchase a home later, or buy one while you are working. It doesn't have to be your retirement home, but it's a resource that can be "exchanged" when you reach retirement. Remember that in retirement (in particular if you've not taken up another job) you will find it more difficult to borrow money. Think ahead, yet be flexible. If you single, you may dream of buying a sailboat and traveling the world when you retire. If you've been saving for that dream, get married and have a child, it's not difficult to adjust your focus and now dedicate the sailboat account to your child's education. There’s one simple trick for saving for any goal: Spend less than you earn. Step Eight - Other considerations. Your health. What's the point of working hard, and investing for the future, if you die prematurely from an avoidable illness, or spend your retirement years in misery. In general, to reach your maximum life expectancy with the greatest health, medical science recommends a diet containing proper nutrients, including vital minerals that may only be necessary in "trace" amounts, limited calorie intake, moderate exercise, avoiding toxins, etc. See your physician for individual advice, and most importantly, FOLLOW the advice. Your activities. As touched on in insurance above, a lawsuit can destroy the best financial plan, resulting in your investments being ordered delivered to someone you injure. The best recommendation is to avoid activities which are likely to lead to problems. If you're prone to violent conduct and fighting, seek anger management training. If you speed, slow down. If you tend to "drink and drive", STOP. Social Security. You probably notice the deduction every pay on your LES for social security, also referred to as the "payroll" tax, FICA, or OASDI. Regardless of the name, it's a tax imposed on all income earned from labor, up to a federally determined limit. (The tax is NOT applied to income from investments, such as interest, rental property income, capital gains, etc.) The Social Security program is a topic which you may have noticed causes "heated" coverage in the media when discussed in Washington. There are a few simple facts however about the system. From the beginning, and as of the date this is written, the Social Security tax has taken in more money annually than has been paid out. The advertised theory is that the difference has been saved in a "trust account", and that should the time come when Social Security taxes not be sufficient to make Social Security payments, that money will be withdrawn from the "trust account" to make the payments. This theory fails to mention though that every cent which was "deposited" into the "trust account", was then exchanged for an "IOU" from the treasury department, and the money spent. Given this financial fact, for every additional dollar paid out by the Social Security Administration, there MUST be: a reduction in some other federal spending, an increase in a federal tax (Social Security, income tax, etc.), or an increase in the federal debt. In the past, whenever the government saw a Social Security "shortfall", the general cure was to increase the Social Security tax rate, or to increase the amount of salary which would be taxed, either way increasing the amount of tax collected. However, in that the (current) means of calculating how much each retiree is to be paid is based, at least in part, on how much tax they paid, every time a shortfall was cured by this method, it meant that a larger future shortfall was created. In the aftermath of World War II, there was a significant surge in births in this country, often referred to as the "baby boom". It is generally recognized that this baby boom generation comprises a significant percentage of the population, that they have among the highest earnings in the country, and pay a significant portion of the Social Security tax, and therefore under the current system are estimated to be "entitled" to significant payments. The baby boom generation begins to be eligible for Social Security in 2008. At this time there are no clear plans as to how the government will deal with the shortfall between decreased tax revenue and greatly increased payments. The Supreme Court has already determined that Social Security payments are not a "right", or even a contracted for entitlement. These payments are in essence simply a welfare payment, subject to change by the government at any time. Until it is clear how the government intends to deal with the shortfall, you should plan your personal retirement as though you will not be eligible for Social Security. "Big picture" factors. In making long-term investments, and plans for your future, the recent news as emphasized that world political stability cannot be ignored. The suicide attacks of 9/11/01 not only resulted in the tragic loss of many innocent lives, and significantly impacted the airline and travel industries, but sent repercussions throughout our economy. In the current global infrastructure, distant events can have great local impact. Food for thought includes: International tensions. Not merely the big issues, such as nuclear, chemical, and biological weapons, but a growing number of nations face the simple inability to feed populations which have grown beyond the local resource capabilities. Fresh water. In recent news was southern California cities being ordered to cut back on how much water they took from the Colorado River. Large areas of Arizona have had so much underground water pumped out that the surface land is subsiding as much as twenty feet. The Oglala Aquifer in the central portion of the USA, which waters millions of acres of crops, is being pumped down far faster than rainfall can refill it. Energy. California continues to experience energy concerns, after long refusal to allow new generators to be built, is now building in earnest. The greatest energy source used in the world is oil. The greatest concentration of remaining, readily accessible oil is in the middle east. Estimates of the remaining useable supply worldwide (with present technology) is between 800 and 1200 billion barrels of oil (BBL). The global usage in 2001 was 27.5 billion barrels (BBL). Absent new discoveries of supplies, or improved technology, and if pumping continues at the present rate, remaining supplies can be expected to be exhausted in no later than 29 to 43 years. Global warming / Global cooling. There still seems to be two "camps" about the overall temperature change of the world, each with their own resulting disasters. In warming, the oceans rise, and the "temperate" zone moves further north. In cooling, the ice caps build to such a point that they throw the rotation of the Earth off. Who's right? Who knows. If EITHER is right, it's hard to say what your plans should be... UFO's? Who knows, maybe we'll actually make contact with an alien race... it may be peaceful, it may be beneficial, or it may not.... Key aspects are: recognizing what you have, what you need to plan for, determining which aspects must take priority, and taking action. FINANCIAL PLANNING COMPOUND INTEREST Albert Einstein once referred to compound interest as "the greatest mathematical discovery of all time". Well, it's not really a scientific discovery, in fact it is a quite simple concept. When you deposit money (capital) in an interest paying account you earn interest on your capital. The next year you earn interest on both your original capital and the interest from the first year. In the third year you earn interest on your capital and the first two years' interest. You get the picture. The concept of earning interest on your interest is the miracle of compounding. The same idea applies to buying an asset that appreciates in value. 1. Start Early! The earlier you start investing, the more time you leave for compound interest to take effect. In the following examples, you save $100 per month, and deposit your savings into into a 5% interest account. Starting Age / Age End Deposits / Est. Value at Age 62 20 62 $170,000. 20 40 $125,000 You stop saving when you're 40, and leave the account alone. 30 62 $80,000 You didn't start to save until you were 30 and put money in until you're 62. 30 40 $49,000 You didn't start to save until you were 30 and only put in money until you're 40. Waiting to start saving is a mistake. Taking money out of savings early on is a mistake. 2. Small differences in return matter a lot! Over long periods of time, the difference between investing at, say, 5% and 8% is enormous. In the above compound example, if your interest rate was 8% instead of 5%, here's how the numbers would change. Starting Age / Age End Deposits / Est. Value at Age 62 20 62 $412,000. 20 40 $340,000 You stop saving when you're 40, and leave the account alone. 30 62 $177,000 You didn't start to save until you were 30 and put money in until you're 62. 30 40 $18,000 You didn't start to save until you were 30 and only put in money until you're 40. 3. Don't squander your capita on parties, booze, and fast cars. Investing, like most things in life is a balance between enjoying yourself now and providing for your future. Not only though do these take a toll on your investment program, but they also endanger your financial future by increasing your risk of serious liability. It only takes a careless moment for you to cause serious injury to someone else, potentially destroying their life, and ruining your future as well. An arrest record can be a significant "roadblock" to your career. Even without causing an injury to someone else, or an arrest, too much "partying", or even a single incident of experimenting with the wrong "substance", can lead to significant enduring health problems for you, forcing you to expend your life savings in medical care rather than enjoying a healthy carefree retirement. 4. Tax free / Tax deferred. Over time, regular saving of quite small amounts can build up an astonishing sum of money. The miracle of compound interest works best for you if your savings earn interest without the need to pay income tax each year on the interest. Otherwise, that small bite that "Uncle Sam" and your state taxes takes each year can make a significant difference in your "bottom line". Accounts that avoid, or delay taxes include: Tax free money market account. Available from many sources, this type of account typically provides you with a "checkbook" from which you can write checks to access your money. (Good for short-term savings.) Series E savings bonds. Defers taxes on the interest until the bonds are cashed. (Good for short-term savings, as well as money that is for "emergencies", in that if the emergency does not strike further deferred is possible when the bond matures.) Thrift Savings Plan (TSP). Provides deposits from your salary that are pre-tax, which is a bonus to you even before interest starts to accrue. "Uncle Sam" also has a matching program where money is deposited on your behalf that is in addition to that which is withdrawn from your salary. All of these deposits grow tax-deferred, but with limitations on withdrawals. The investment options within a TSP account are limited to the choices the government offers. While TSP contributions (i.e. due to employer matching) should take priority over an IRA, when used as part of a comprehensive investment plan, perhaps you should consider your TSP as your cash / interest bearing "safe haven". (Good for long term investments.) Individual Retirement Accounts. (Traditional IRA and ROTH IRA) While your IRA deposits can be placed into a simple interest bearing account, in that these accounts provide an almost unlimited range of choices for investment, when used in conjunction with a comprehensive plan that includes a more limited choice such as the TSP, perhaps you should consider an IRA as money used more for seeking capital gains (profit on the increased value of an investment, rather than a guaranteed interest rate). Taxable accounts. Bank Checking and Savings. (Includes credit union accounts) Certificates of Deposit. Provide a guaranteed rate of interest, for a fixed period of time, with a guarantee that the original amount will be repaid at the end of the term. Bonds. (NOT U.S. Savings Bonds) Corporations, cities, States, etc. will often issue "bonds" as a means of financing projects. The interest rate is fixed for the entire period of the bond, which is sometimes as long as 30 years. There can though be serious risk of LOSS when you invest in this type of bond. 5. Persistence and patience are required. Saving for 40 years is obviously something you can't do overnight. You must consistently exercise restraint and avoid the temptation to withdraw your long term savings for the latest commercial "toy". The Rule of 72 Although a spreadsheet can help you work out exact estimates of the effects of compound interest there is also a handy shortcut known as the Rule of 72. It states that you can find out how many years it will take for your investment to double by dividing 72 by the percentage rate of growth. So it will take 9 years for your investments to double if they grow at 8% a year (72/8=9). But it will only take 6 years if your investments grow at 12% and so on. Estate and Financial Planning - Providing Assets for the Future - 2 - 3 - 4 - 5 - 6 - 7 - 8